Conventional wisdom tells us that if we pay less for something that is a good thing. This is what all analysts are taught when we begin our study of capital markets. For this particular newsletter, we are going to look at future earnings. The conventional wisdom would tell us to pay as little as possible for each unit of future earnings as we are able to. Historically, this approach has been proven to provide an investing edge; and indeed, all things being equal we would all prefer to buy something cheaper. But we must consider the externalities that exist in the marketplace. Not every unit of future earnings is worth the same price.
The market has been paying a premium for US-based equities for a long time now. This can be visualized in the chart above. We can see a steady downward slope in the valuation of international stocks in relation to domestic stocks since December of 2009 when the market was paying about the same for earnings in developed international equities (EAFE) and emerging market equities (EM) as domestic equities (S&P500). Since that past point of parity in 2009, the international shares have gotten significantly cheaper, currently sitting at 70% of the S&P 500 for the EAFE and 60% for EM. According to conventional wisdom, this means that forward-looking returns should be far better for these markets than the S&P 500. But that has not been how this has worked out.
The S&P 500 has been far and away from the better performer all while significantly overvalued compared toEAFE and EM. Why is that? Well there are a myriad of reasons, but maybe foremost in investors’ minds is uncertainty. There is a lot of uncertainty in the world, but there is less in the US. That makes us a safer place to invest. Think of EM countries – there is an enormous amount of uncertainty surrounding their rule of law(see our quote of the week for an example). We have seen Russia and China both stumble considerably with rule of law recently. Russia with its autocratic regime that does not care a whiff about laws, and China with their refusal to submit their companies to independent auditors eroding trust in the numbers that Chinese companies report. Even countries in Europe have been hit recently by their own bout of uncertainty surrounding the war.
These are really all just confirming signals to the price action that we have seen over the past decade that has led us to be overweight US vs international equities. That price action is on full display in the chart above.
Performance is no guarantee of future results. Trend signals are proprietary research of EWM Investment Solutions, a wholly owned subsidiary of Executive Wealth Management, LLC. Data source for returns is FactSet Research Systems Inc. This chart is not intended to provide investment advice and should not be considered as a recommendation. One cannot invest directly in an index. Executive Wealth Management does not guarantee the accuracy of this data.
On Tuesday, March 21st, the EWM Emerging Growth Companies model removed a holding in the electric vehicle industry. There were no other trades in the EWM Investment Solutions models during the week ending on March 26th, 2022, with domestic equity market sectors still maintaining their long-term favorable trend.
Quote of the Week
When you invest in China, there’s no point for documents. Even if I have a document, where do I go to enforce it?
Hwee Bin Lim, wife of ex-Goldman Sachs banker Roger Ng, testifying in court last week during Ng’s trial for his alleged involvement in the Malaysian sovereign wealth fund scandal. Lim was defending the absence of documentation on the source of her family’s recent wealth and reiterating a common opinion about the lack of transparency in the Chinese capital markets.
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Returns are calculated as indicated below with reinvested dividends not considered except for the Barclays U.S. Aggregate Bond Index. Data source for returns is FactSet Research Systems Inc. The London Gold PM Fix Price is used to calculate returns for gold.
1 Week = closing price on March 25, 2022 to closing price on April 1, 2022
1 Month = closing price on March 1, 2022 to closing price on April 1, 2022
3 Month = closing price on December 31, 2021 to closing price on April 1, 2022
YTD = closing price on December 31, 2021 to closing price on April 1, 2022
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